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INSURANCE |
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THE SECURITIZATION OF INSURANCE RISK: CATASTROPHE BONDS
Catastrophe (cat) bonds are one of a number of innovative risk transfer products that are emerging as an alternative to traditional insurance and reinsurance products. Insurers and reinsurers typically issue cat bonds through an issuer known as a special purpose vehicle, a company set up specifically for this purpose. Cat bonds pay high interest rates and diversify an investor's portfolio because natural disasters occur randomly and are not associated with economic factors. Depending on how the cat bond is structured, if losses reach the threshold specified in the bond offering, the investor may lose all or part of the principal or interest.
A study by Guy Carpenter released early in 2008 reveals a high level of transaction activity in 2007, even as rates softened for traditional reinsurance capacity. At year-end, cat bond risk capital outstanding reached $13.8 billion, a 63 percent increase over 2006’s record-setting year-end total of $8.5 billion. Cat bond risk principal now accounts for 12 percent of property limits in the U.S. and 8 percent on a worldwide basis. The study also reports that publicly disclosed cat bond issuances totaled $7 billion in 2007, a 49 percent increase over the record $4.7 billion in 2006. Some 27 transactions were completed in 2007, up from 20 in 2006 and nearly tripling the 10 placed in 2005.
The Guy Carpenter study also reports on the use of "extreme mortality bonds" to transfer mortality risk to the capital markets. In 2007 there was only one such transaction, Swiss Re's sponsorship of a $700 million bond through its Vita Capital III special purpose vehicle. Guy Carpenter expects future capital markets activity in this area to be high.
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TOP TEN CATASTROPHE BOND TRANSACTIONS, 2007
($ millions)
Rank |
Special purpose vehicle |
Sponsor |
Risk amount |
Peril |
Risk location |
| 1 | Merna Reinsurance Ltd. | State Farm | $1,058.6 | Multiple | U.S./Canada |
| 2 | Residential Reinsurance 2007 Limited | USAA | 600.0 | Multiple | U.S. |
| 3 | Longpoint Re Ltd. | The Travelers | 500.0 | Hurricane | U.S. |
| 4 | Redwood Capital X Ltd. | Swiss Re | 498.6 | Earthquake | California |
| 5 | Spinnaker Capital Limited | Swiss Re | 380.2 | Hurricane | U.S. |
| 6 | Blue Fin Ltd. | Allianz SE | 290.7 | Windstorm | Europe |
| 7 | Green Valley Ltd. | Groupama SA | 288.0 | Windstorm | France |
| 8 | Gamut Re Ltd. | Nephila Capital Ltd. | 265.0 | Multiple | U.S./Europe/Japan |
| 9 | Midori Re Ltd. | East Japan Railway (1) | 260.0 | Earthquake | Japan |
| 10 | Calabash Re II Ltd. | Ace American Insurance Company (2) | 250.0 | Hurricane, earthquake, multiple | U.S. |
(1) Sponsored through Munich Re.
(2) Sponsored through Swiss Re.
Source: GC Securities. |
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CATASTROPHE BOND TRANSACTIONS BY SPONSOR TYPE, 1997-2007
($ millions)
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Insurer |
Reinsurer |
Corporate |
Total |
Year |
Capital |
Number |
Capital |
Number |
Capital |
Number |
Capital |
Number |
| 1997 | $521.0 | 4 | $112.0 | 1 | NA | NA | $633.0 | 5 |
| 1998 | 575.0 | 4 | 271.1 | 4 | NA | NA | 846.1 | 8 |
| 1999 | 460.0 | 4 | 424.8 | 5 | $100.0 | 1 | 984.8 | 10 |
| 2000 | 469.0 | 4 | 670.0 | 5 | NA | NA | 1,139.0 | 9 |
| 2001 | 150.0 | 1 | 816.9 | 6 | NA | NA | 966.9 | 7 |
| 2002 | 195.0 | 2 | 849.5 | 4 | 175.0 | 1 | 1,219.5 | 7 |
| 2003 | 730.0 | 3 | 768.0 | 3 | 231.8 | 1 | 1,729.8 | 7 |
| 2004 | 600.0 | 3 | 542.8 | 3 | NA | NA | 1,142.8 | 6 |
| 2005 | 1,071.0 | 4 | 920.1 | 6 | NA | NA | 1,991.1 | 10 |
| 2006 | 2,575.3 | 12 | 1,908.2 | 6 | 210.0 | 2 | 4,693.5 | 20 |
| 2007 | 3,603.6 | 10 | 3,132.7 | 16 | 260.0 | 1 | 6,996.3 | 27 |
| Total | $10,949.9 | 51 | $1,0416.0 | 59 | $976.8 | 6 | $22,342.7 | 116 |
NA= Data not available.
Source: GC Securities. |
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CATASTROPHE BOND RISK CAPITAL BY SPECIFIC PERIL, 1997-2007
($ millions)
Year |
U.S. earthquake |
U.S. hurricane |
Europe windstorm |
Japan earthquake |
Japan typhoon |
Other |
| 1997 | $112.0 | $395.0 | NA | $90.0 | NA | $36.0 |
| 1998 | 145.0 | 721.1 | NA | NA | $80.0 | 45.0 |
| 1999 | 327.8 | 507.8 | $167.0 | 217.0 | 17.0 | 10.0 |
| 2000 | 486.5 | 506.5 | 482.5 | 217.0 | 17.0 | 129.0 |
| 2001 | 696.9 | 551.9 | 431.9 | 150.0 | NA | 120.0 |
| 2002 | 799.5 | 476.5 | 334.0 | 383.6 | NA | NA |
| 2003 | 803.8 | 416.1 | 474.1 | 691.2 | 277.5 | 100.0 |
| 2004 | 803.3 | 660.8 | 220.3 | 310.8 | NA | NA |
| 2005 | 1,269.0 | 994.0 | 830.1 | 138.0 | NA | 405.0 |
| 2006 | 2,228.7 | 2,294.9 | 1,166.0 | 824.1 | 400.3 | 507.5 |
| 2007 | 3,630.0 | 4,631.6 | 1,678.9 | 1,160.0 | 725.0 | 1,913.9 |
| Total | $11,302.4 | $12,156.1 | $5,784.8 | $4,181.6 | $1,516.8 | $3,266.4 |
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NA= Data not available.
Source: GC Securities. |
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WEATHER-RELATED HEDGES
Weather-related derivatives and insurance allow such businesses as ski resorts, oil and propane gas distributors, and others that may experience large swings in annual sales due to weather conditions, to hedge their weather-related risk.
Developed initially by an energy company in the late 1990s and now being offered by insurers and reinsurers, weather derivatives typically are indexes derived from average temperatures, snowfall or rainfall. Weather derivatives come in the form of options or swaps. A weather option is a trade that pays an agreed upon amount at a specific time, based on the occurrence of certain weather conditions, such as summer temperatures more than five degrees below average. A weather swap is an exchange of funds between two entities likely to experience different conditions. Money changes hands for every point above or below a certain threshold. Contracts can be tailored to meet specific needs.
Companies can also buy a weather insurance policy. These policies generally have a dual trigger, one weather-related, such as “heating degree days,” and the other based on reduced sales or some other economic indicator. These products are treated differently from derivatives in terms of accounting and taxation.
Weather-related hedge products are different from other kinds of weather insurance, such as policies that protect against specific events being canceled due to poor weather. They are also different from catastrophe bonds. (See the Securitization of Insurance Risk, page __.)
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PARTICIPANTS IN THE 2007 WEATHER RISK MANAGEMENT ASSOCIATION SURVEY (1)
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GLOBAL WEATHER RISK PRODUCTS,
NOTIONAL VALUE OF CONTRACTS, 2002-2007 (1)
($ millions)
Year (2) |
Over the counter |
Chicago Mercantile Exchange |
Total (3) |
| 2002-2003 | $3,501 | $686 | $4,188 |
| 2003-2004 | 2,753 | 1,868 | 4,621 |
| 2004-2005 | 4,169 | 5,527 | 9,696 |
| 2005-2006 | 2,347 | 42,897 | 45,244 |
| 2006-2007 | 1,869 | 17,324 | 19,193 |
(1) Based on companies responding to a survey conducted by PricewaterhouseCoopers for the Weather Risk Management Association plus Chicago Mercantile Exchange trades.
(2) The surveys run from April to March.
(3) May not add due to rounding.
Source: PricewaterhouseCoopers. |
| - Chicago Mercantile Exchange trades accounted for 90.3 percent of the notional value of weather risk contracts tracked by the Weather Risk Management Association (WRMA) in 2006-2007.
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GLOBAL WEATHER RISK PRODUCTS,
NUMBER OF CONTRACTS, 2002-2007 (1)
Year (2) |
Over the counter |
Chicago Mercantile Exchange |
Total |
| 2002-2003 | 4,517 | 36,195 | 40,712 |
| 2003-2004 | 3,162 | 106,675 | 109,837 |
| 2004-2005 | 4,057 | 223,139 | 227,196 |
| 2005-2006 | 2,180 | 1,041,439 | 1,043,619 |
| 2006-2007 | 774 | 729,283 | 730,057 |
(1) Based on companies responding to a survey conducted by PricewaterhouseCoopers for the Weather Risk Management Association plus Chicago Mercantile Exchange trades.
(2) The surveys run from April to March.
Source: PricewaterhouseCoopers. |
| - The Chicago Mercantile Exchange accounted for 99.9 percent of weather contracts tracked by WRMA in 2006-2007.
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